Fed Said to Study How Banks Manage Deposits After JPMorgan Loss

JPMorgan Chase & Co.’s $2 billion trading loss has prompted the Federal Reserve Bank of New York to examine how banks in its district are managing a wave of deposits that has flooded the financial system since the credit crisis, according to a person familiar with the matter.

New York-based JPMorgan’s trading loss, announced last week, occurred in its chief investment office, which oversees about $360 billion, the difference between deposits and what the bank lends. The New York Fed is investigating how other banks it regulates are investing deposits that aren’t loaned out, said the person, who wasn’t authorized to discuss the matter publicly and declined to be identified.

Banks are struggling to manage an influx of deposits as investors take advantage of a bigger federal guarantee and the perceived safety of the largest banks.

Total deposits at institutions insured by the Federal Deposit Insurance Corp. rose to about $10.2 trillion at the end of last year from $8.2 trillion in the third quarter of 2007. In the same period, total loans fell to $7.5 trillion from $7.7 trillion. Securities in bank portfolios rose to $2.9 trillion from $2 trillion, according to FDIC data.

In October 2008, President George W. Bush signed a bill that temporarily increased deposit-insurance coverage to $250,000 per depositor from $100,000. The Dodd-Frank Act overhauling financial regulation, which President Barack Obama signed in 2010, made the increase permanent.

Conference Call

JPMorgan Chief Executive Officer Jamie Dimon said on a conference call with analysts on May 10 after announcing the loss that all banks have “these fairly large portfolios” that invest excess cash. Dimon had encouraged the unit to boost earnings by buying higher-yielding assets, including structured credit, equities and derivatives, ex-employees said in April.

“I should point out to all the folks on the phone, you could see - you can go to the 10-Q and see what people have in those portfolios,” Dimon said on the call, referring to quarterly report filings. “And some banks do some things, and some do others. But to invest those excess deposits, you buy securities. That’s been going on for 100 years in banking.”

Federal Reserve Governor Daniel Tarullo has overhauled the Fed’s supervisory approach from a bank-focused examination process to a broader systemic view that compares practices at several institutions at once. The main forum for such reviews is the Large Institution Supervision Coordinating Committee, or LISCC, which includes top supervisors from the Fed’s regional banks and also economists, financial-markets experts and computer modelers from the Fed Board.

Horizontal Approach

“We have supplemented the traditional, firm-by-firm approach to supervision with a routine use of horizontal, or cross-firm, reviews to monitor industry practices, common trading and funding strategies, balance-sheet developments, interconnectedness, and other factors with implications for systemic risk,” Fed Chairman Ben S. Bernanke said in a speech last month in Stone Mountain, Georgia.

Federal Reserve Board spokeswoman Barbara Hagenbaugh declined to comment. She said earlier this week that the central bank, as JPMorgan’s holding-company supervisor, is studying organizational issues around the trading loss to ensure that they aren’t repeated in other areas of the bank. The loss underscores the importance of capital buffers, she said.

The Office of Comptroller of the Currency said this week it is examining JPMorgan’s activities and its transactions following the $2 billion loss.

“Our examiners are also evaluating risk management strategies and practices in place at other large banks to validate our understanding of inherent risk levels and controls of these risks,” said OCC spokesman Bryan Hubbard. The OCC oversees national banks, including JPMorgan Chase Bank N.A.

Dimon announced his bank’s “egregious” trading loss on May 10, two months after the biggest U.S. bank by assets passed a Fed stress test that put its loans and securities through a scenario of deep recession and a simulated global financial market shock. The bank’s flawed positions on synthetic credit holdings could result in an additional $1 billion loss or more as they’re wound down, Dimon said.